Friday, July 27, 2007

IOSCO Roundtable on Audits Examines Fraud Detection and Liability

Participants at a recent IOSCO roundtable on public company audits agreed that the current certification is not entirely adequate. They suggested that the auditors’ position be expanded to include judgments, with additional information to be provided, such as business matrices and other information used by the industry to estimate the future value of companies. The roundtable also believes that audits of large and complex companies could be enhanced through the use of internal auditors. It might also be useful to implement some fraud enhancement mechanisms within the regular audit process, although separate forensic investigations were generally not deemed appropriate.

Former SEC Chief Accountant Lynn Turner said it is crucial that the numbers presented in financial statements be accurate. Financial statements are a snapshot of a company at a given moment, he noted, and the role of auditors is to provide a high level of assurance that this snapshot is accurate. If they are unable to offer such assurance, he posited, it would significantly change stock pricing and capital allocation activities.

On the question of auditor liability, the former chief accountant said that, before applying any liability caps, greater transparency should be required on the part of auditors. Since auditors have not made their financial information public, they have not provided any financial reason for imposing caps. Auditing firms would not even adopt the good governance practices required of public companies, which the former SEC officials sees as problematic, considering the important public function they provide to the worldwide capital markets.

Michael Cook former Deloitte CEO, mentioned that, following the financial debacles of Enron and others, there has been a pronounced cultural shift within the financial reporting community from making the numbers to doing it right. In his view, the large number of material weaknesses and restatements is actually proof that the system is working properly, since people are making significant changes in their reporting systems.

Paul Koster, chair of CESR-FIN, related that the European Commission has made great efforts, within the Financial Services Action Plan, to improve the reliability of financial statements. Many directives have been introduced, such as the Transparency Directive, and the Audit Directive.

Mr. Koster, who is also a member of the Netherlands Authority for Financial Markets also reiterated his position that financial statements should include an accountant’s discussion and analysis. Such information would also help the auditing profession make a better impression on the financial markets, by communicating how well they are performing their tasks.

On the issue of auditor fraud detection, Lynn Turner advocates the adoption of a better fraud standard in the context of a regular audit, and eschews the conducting of a separate forensic audit. He also noted that auditors are still not using procedures that are used by other professionals, such as hedge fund analysts, to greatly enhance the possibility of detecting fraud.

Consequently, it is not unusual for an analyst to detect fraud where an auditor failed, although the latter has access to the company records. In Enron, he noted, two large hedge funds managed to detect that the company’s books were cooked, while the outside auditor did not.